Assets under Management
Assets under management (AUM), sometimes called fund under management, measures the total market value of all the financial assets which an individual or financial institution such as a mutual fund, venture capital firm, or depository institution or a decentralized network protocol controls, typically on behalf of a client. These funds may be managed for clients/users or for themselves in the case of a financial institution which has mutual funds or holds its own venture capital. The definition and formula for calculating AUM may differ from one entity to another.
The amount of assets under management changes due to:
- The value of the securities in which AUM is invested. For example, a mutual fund will experience an increase (decrease) in AUM when the market value of its securities increases (declines).
- Inflows and outflows of funds. For example, investors in a mutual fund may increase or reduce the size of their investment by buying additional shares in the fund or by selling the ones they already own, which will change the total size of the fund’s AUM.
- The number of dividends paid by the companies in the institution’s portfolio, if reinvested and not distributed.
Net Asset Value
Net Asset Value is the net value of an investment fund’s assets less its liabilities, divided by the number of shares outstanding. Most commonly used in the context of a mutual fund or an exchange-traded fund (ETF), NAV is the price at which the shares of the funds registered with the Securities and Exchange board of India (SEBI) are traded.
Net Asset Value = (Value of Assets – Value of Liabilities ) / Total Outstanding Shares
There are two types of net asset value calculation.
- All the mutual fund investment companies evaluate the total worth of their portfolio daily after the stock market closes at 3:30 pm. The market reopens the day after with the closing prices of the previous day. The fund houses accordingly deduct all the expenses to get the net valuation of the assets for the day, using the formula mentioned above.
- The general net value of assets is the price of its equity share and is given by the cumulative cost of individual shares. This calculation gives the market value of a particular asset and is subject to change as per market fluctuations.
Exchange Traded Funds
An exchange-traded fund (ETF) is a type of investment fund and exchange-traded product, i.e. they are traded on stock exchanges. ETFs are similar in many ways to mutual funds, except that ETFs are bought and sold from other owners throughout the day on stock exchanges whereas mutual funds are bought and sold from the issuer based on their price at day’s end. An ETF holds assets such as stocks, bonds, currencies, futures contracts, and/or commodities such as gold bars, and generally operates with an arbitrage mechanism designed to keep it trading close to its net asset value, although deviations can occasionally occur. Most ETFs are index funds: that is, they hold the same securities in the same proportions as a certain stock market index or bond market index.
There is an interesting difference between mutual funds and ETFs. Unlike mutual funds which are originated and redeemed by the fund house or AMC, the ETFs are traded in the secondary market like shares and their availability is based on liquidity. ETFs are closed ended and any purchase or sale only changes the ownership and does not change the basic corpus of the ETF. ETFs can be held in your demat account and sold and bought and through your trading account.
Features:
- Intraday Trading: Since Exchange Traded Funds (ETFs) trade on stock exchanges, investors can buy and sell them during trading hours like regular stocks. They can be traded at market prices using different types of orders, which gives traders optimal pricing for their trades and the option of instant liquidity
- Low Costs: ETFs typically have lower management fees and expenses than actively managed mutual funds’ investments.
- Diversification: ETFs ability to track an index to incorporate all or a representative sample of the securities that make up the index, gives an investor a diversified portfolio that may have lower variability compared to individual securities.
- Transparency: Portfolio and Price are the two transparency aspects of ETFs, as Index ETFs hold the same securities as the indexes they track, which enables investors to know precisely what they are invested in.
- Access to Niche Markets and Asset Classes: Investing in markets and asset classes, which were earlier difficult to access, like small emerging markets, commodities, currencies and alternative investments, is now possible due to the wide range of ETFs available for retail investors.
- Increased Choices for Portfolio Construction: Multiple investment themes and strategies available through ETFs give investors multiple choices for portfolio construction.
- Potential Tax Efficiency: Because of lower portfolio turnover and in-kind redemptions, ETFs potentially have greater tax efficiency than mutual funds
- Low Investment Threshold: Investors can construct diversified portfolios via ETFs with a low investment threshold.
- Elimination of Manager Risk: With the objective to track an index and not outperform it, manager risk is virtually eliminated in an ETF.
Advantages:
Ease of understanding
A key benefit of exchange-traded funds is that the investment returns are easy to understand. Benchmark indices are often constructed using back-tested techniques and aimed to be a true representative of the markets. Such indices are often broadly discussed in investor discussions.
An index movement is often more likely to be discussed in social conversations than specific stock price movements. Understanding indices’ performance may be, thus, simpler and more straightforward for investors. Understanding the investment performance is also easier for investors, as ETFs tend to mirror the returns generated by the underlying indices.
Portfolio diversification
It is often advised to maintain a diversified investment portfolio and not keep all your eggs in one basket. Diversification helps investors to spread the investment risk across different instruments. With ETFs tracking an underlying index, the diversification advantage embedded in the indices is automatically passed on to the ETF investment portfolio.
Cost-effectiveness
Since the role of fund managers is limited to managing the investment portfolio, ETFs carry relatively low fund management expenses. This results in ETFs becoming a cost- effective investment option for investors.
Elimination of unsystematic risks
ETFs tend to mitigate unsystematic risks, which get eliminated with the product design. When investing in financial markets, there are two types of investment risks: systematic and unsystematic. Systematic risks refer to the possibility of adverse changes in portfolio valuation due to macroeconomic events.
In contrast, unsystematic risks refer to the risk of making a wrong investment decision. Since ETFs follow a passive investing strategy, the unsystematic risk gets eliminated automatically; therefore, the overall investment risk is lowered.
Disadvantages:
Over Diversification
Many ETFs participate in over diversification. ETFs are generally not actively managed, but are programmed to follow a specific index. The index, and therefore the ETF, may not own the very best stocks.
It may be more advantageous to buy a limited number of the best companies rather than own the entire index. This would be particularly true with ETFs that track indices with a small universe of stocks such as a specific sector or industry.
Lack of Rebalancing
Most ETFs don’t rebalance their portfolios. Remember, usually an ETF is programed to track an index. In an index, as the winners increase in price they become a larger percentage of an index. At the same time some stocks decline in price and become a smaller percentage of an index. By owning the index, or ETF tracking the index, you may own more of expensive over priced stocks and less of the bargain underpriced or value stocks.
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